Incentivise your employees

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Which is better – an employee share option plan or an employee share scheme?

It is often said being in business is not always easy, but it certainly can be rewarding both personally and financially.

In the early stages and during growth phases of a business it is often difficult to attract and retain talented employees. At the other end businesses owners are often faced with how they transition into retirement and have they adequately thought through a succession plan.

We are often asked about whether a business should consider an Employee Share Option Plan or an Employee Share Scheme. Both apply to businesses operating as an incorporated entity.

So, what are the differences?

Employee Share Option Plan (ESOP)

An ESOP is where a company grants an option to purchase shares in the company.

An option does not grant the employee any rights that a shareholder of the company has such as voting rights, receiving dividends etc.

The employee can exercise the option at a future date to subscribe for the shares in the Company.

The benefit and appeal for an employee is that an option is non-binding and does not have to be exercised.  It is attractive to an employee because the price to exercise the option is fixed at the time of the agreement was entered into it.

From an employer’s perspective issuing options does not dilute the current shareholding and the founding shareholder can maintain control, decide the price and not disclose confidential company information.

Employee Share Scheme (ESS)

An ESS is where a company gives an employee a ‘right’ to purchase shares in the form of a subscription.

The company invites the employee to subscribe for the shares at a certain price.

The subscription price can be set at a nominal amount, fair market value or anywhere in between.

It is important to note any restrictions on the shares and any discount to fair market value will have taxation implications for the employee.

Which one is appropriate?

Both ESOP’s and ESS’s are valuable tax planning tools which drive start-ups, growing and established businesses.

It can be invaluable in engaging and keeping employees.

There is a great deal of flexibility when developing a scheme for example:

  • A premium share plan allows for employees to purchase shares at above market value;
  • A phantom share plan allows for bonuses to be pinned to the rise or fall of the share price;
  • Using an employee share trust; and
  • Using non-ordinary shares, such as dividend only shares.

The taxation implications affect both the employee and the employer with significant tax concessions available but also significant tax liabilities

It is important to gain the right professional advice when considering implementing a scheme.

What are the tax implications?

For the employee, the tax can be treated as follows:

  • Upfront taxation where the employee is subject to tax on the discount when the shares are issued;
  • Deferred taxation where the employee is subject to tax on the discount at a later date; or
  • Start-up concessions with upfront taxation where tax payable on the upfront taxation is ignored and the employee is only subject to tax when a CGT event occurs (i.e. a sale of the shares); or
  • The $1,000 discount – some schemes may be eligible to discount of up to $1,000 if certain criteria are met.

Start-Up Concessions

These schemes can be critical for start-ups and the implications for ESOP’s and ESS’s which must be satisfied are:

  • the company must not be listed on a stock exchange;
  • the company must be less than 10 years old;
  • all companies in the group must have less than $50m turnover;
  • the company must be an Australian tax resident;
  • the interest (shares or options) must be held for 3 years, with some exemptions;
  • each employee is limited to 10% shareholding when the interests are issued;
  • the interest must relate to ordinary shares;
  • it must be offered to at least 75% of employees with more than 3 years of service; and
  • Either;
    • If shares are used, the discount to market value is a maximum of 15%; or
    • If options are used, the strike price (the price at which the option can be exercised) must be equal to market value on the date the options are issued.

If the company and scheme meet these criteria the employees are taxed on the capital gain on the profit from a sale of the shares and not on the upfront cost of purchase.

Employees may also be eligible for the 50% Capital Gains Tax (CGT) discount and issuing the interests to a family trust to split any capital gain.

How can we help incentivise your employees?

Our business and corporate services team has years of experience assisting companies at all stage of their growth and with their succession planning. We have assisted businesses and companies right around Australia with employee incentive schemes.

Contact us to discuss how we can assist you incentivise your employees or with any employment law questions.

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